Convergys observers weigh potential post-IPO picture

Convergys Corp. shareholders hope a potential spin-off of the firm’s billing unit could finally garner returns promised since its stock price began plummeting last July.

Downtown-based Convergys announced this week its plan to evaluate a separation of its lucrative information management unit from its customer care and human resource management divisions, forming a second publicly traded company. It hired New York financial adviser Centerview Partners to advise the board and senior management and help them make a decision by year’s end.

Convergys’ information management division employs 3,100 workers, including 500 locally. In all, Convergys has 2,200 workers in Greater Cincinnati. It is unclear how a spin-off would impact local employment.

Convergys CEO Dave Dougherty said in a release that the evaluation is “part of our plan to align the company’s assets and capabilities with our leadership in relationship management and to unlock value for shareholders.”

Many shareholders had appeared disgruntled at the annual meeting in April, when the share price sat just 7 percent above the price at its initial public offering in 1998. The company also had failed to meet its 2007 goal of $3 billion in revenue and projected year-end 2008 revenue flat at $2.85 billion. Convergys’ stock price then dipped to $11.90 per share July 25, its lowest price since March 2003.

Activist shareholder

Analysts had anticipated changes when New York-based investment firm Jana Partners bought a 10 percent stake in July. Known as an active investor, it recently bought a 10.5 percent stake in CNet Networks Inc. and pushed to overturn management.

“This was expected given (Jana Partners’) past activism,” said Scott Sutherland, an analyst with Wedbush Morgan Securities in Los Angeles. “Convergys was a very easy target given they had three separate segments with some relation but not a strong one.”

“It’s like somebody advertising you can buy a baseball bat and a new car for $16,000. You don’t want both,” said a more vocal shareholder, Greg Taxin, a partner in New York-based Spotlight Capital Management. “Having the two in one company drags both of them down.”

According to a Sept. 2 report by UBS Investment Research, Convergys without its information management division would look more like a true outsourcing organization, with 88 percent of revenue coming from its call center business and the rest from human resources management, a division that has yet to become profitable.

UBS calls the new company a “pure-play” but said it needs to improve margins to stand on its own. In its second-quarter filing, customer management margins dropped to 4.1 percent from 9.7 percent the year prior and HR management lost $4.2 million on revenues of $59.4 million. That’s better than 2007 operating losses of $17.1 million compared to $63 million earnings.

But it still hurts earnings, analysts say.

“They need to try to get it to profitability, sell it to someone else or shut it down,” Sutherland said.

Spinning off the information management division might provide less of a distraction to Convergys’ efforts to reverse declines, but it also could hurt the firm financially.

Could provide big gains

But a spin-off could provide big gains for shareholders. The UBS report valued information management at about $600 million, or $5 per share. The unit expects to hit that total in revenue by year’s end, with an operating margin higher than 17 percent. It finished the second quarter with $161 million in revenue, down from $183 million in the same period last year, but with margins up to 23.5 percent from 21 percent.

“The software business has low capital intensity and is a pretty steady, high-return business,” Taxin said. “We have advocated this precise action because we believe it will create value.”

It’s certainly a large enough entity to operate as a public company, said Bob Weisman, principal of downtown’s Great Water Capital Partners. But the market for IPOs in 2008 is lousy, he said.

According to Renaissance Capital’s IPOhome.com, 43 companies have completed IPOs this year, down 75 percent from the 171 in the same period in 2007. Volume is down from $59.7 billion to $27.8 billion.

Technology-sector IPOs had been especially hot over the last year, representing almost 19 percent of total volume, but those have dropped drastically in recent months as investors lost interest in speculative and venture-backed companies, data showed.

Further limiting an IPO could be Con­vergys’ debt – Fitch Ratings put it on a negative rating watch following the Tuesday news, claiming the firm would have to renegotiate a $400 million credit facility and redeem senior notes before a spin-off.

But that wouldn’t prevent another buyer from purchasing the unit, Weisman said.

“The adviser is probably looking at all the strategies,” he said. “Presumably, they could get a lot of cash for it and that could be used to pay taxes to the extent they would be due or issue a one-time cash dividend, retire debt or initiate a large buyback of Convergys stock. They basically are saying that this division is up for grabs.”